Although low costs are important, there are other factors tracker investors should consider.
When comparing competing index trackers, at what point do astute investors stop focusing on cost, and start to think about other issues -- issues such as the tracker's replication strategy, the reputation of the fund manager, and the ease of doing business with them?
But first, note the use of the word 'astute' in the preceding sentence. There are still plenty of investors out there for whom comparative tracker costs don't appear to be a concern.
Collectively, for instance, almost a hundred thousand people have some £1.2 billion invested in Virgin's FTSE Tracker, launched to great acclaim back in 1995. Nor is Virgin the only -- or even worst -- offender. Some providers charge more. And some even charge an upfront initial fee as well.
As most Fools know, the key to successful tracker investing is to pick a tracker where more of the gains end up in your pocket, and not the tracker provider's pocket. From the provider's point of view, running a passive tracker isn't expensive, and if you're going to pay out charges of 1% or more, you may as well pay the same money and get active fund management, rather than passive index tracking.
Survey data
Which takes me back to the original question. When looking at low-cost trackers, when does comparative cost start to become secondary to other factors?
Interestingly enough, I happen to know that HSBC Global Asset Management recently asked this very question. The research in question is internal, so you won't be able to find it on the bank's website, or read a press release summary of the results. But, when asked, HSBC was happy to share some of the analysis with me, in the form of raw summary slides.
One quick caveat: the survey sample group was IFAs. And not all the IFAs in question worked on a fee-paying basis with their clients -- the IFA profile most likely to comprise a group that could be expected to compare fairly well with knowledgeable private investors. That said, given that we're talking trackers, commission bias is unlikely, and I couldn't detect any such bias in the data.
Just to be sure, though, HSBC tell me that they plan to ask similar questions of private investors in the months ahead.
A second quick caveat: HSBC (LSE: HSBA) operate the second-cheapest range of trackers on the market -- trackers that in some cases I hold myself. As such, they have a fairly obvious vested interest in the findings. Indeed, they tell me that research like this is generally used to inform their pricing policy. Canny tracker investors will recall that the bank has recently slashed its tracker charges.
Growing interest
The first nugget isn't directly related to cost, but seems well worth sharing anyway. Trackers continue to be popular, with 43% of respondents planning to increase their exposure to them over the next three years -- a fifth of them intending a 'significant increase'.
And a hefty proportion of this interest can be laid at the door of the FSA's Retail Distribution Review, which aims to eliminate 'back door' commission paid to advisers.
If the regime implied by the Retail Distribution Review comes to pass, 41% of respondents saw trackers as a better bet than higher-cost actively-managed funds -- with over half of those who expressed this view referring explicitly to trackers' lower costs.
Testing price points
Which takes us to those costs. Imagine, said the survey, that all index trackers charged 0.25%, and a new provider comes into the market charging 0.20%: would you automatically seek to switch? Just 12% of respondents said 'yes'; while 88% said 'no' -- a sharp reversal of what happens when other numbers are plugged into the same question.
Why? Because at this level of cost, it seems that other factors come into play, as the answers to subsequent questions made clear. While the level of cost was seen as very important -- and indeed, scored highest on a five-part ranking question -- the next most important factor was the method of index replication. In other words, did the index tracker buy and hold the underlying shares in the index, or did it use futures, derivatives, or sampling?
The strength and reputation of the provider was also an important factor. And to a lesser extent, respondents were also concerned about the level of service offered by the provider, and the overall size of the fund in question.
And this was seen at its starkest in a question relating to switching from one provider to another. While 47% of respondents found the combination of a new provider with lower charges an attractive proposition, exactly the same proportion -- 47% -- were prepared to switch in order to benefit from a better tracking methodology.
A new entrant with a stronger name was also seen as compelling, being identified by 29% of respondents as a 'switch' factor -- a cue, I guess for US-based newcomer Vanguard.
What it all means
I found this research interesting. Here on the Fool, we talk a lot about switching to low-cost trackers, and HSBC's survey data is a refreshing reminder that price isn't everything.
Yes, switching out of high-cost trackers into lower-cost providers makes sense when you're talking about (say) switching out of Virgin into a lower-cost provider such as Vanguard, HSBC or Fidelity, but there comes a point at which cost-based switching makes less sense.
"We tested various price points, and there's a level at which price becomes irrelevant, and beyond which other factors become important," says David Chellew, head of marketing at HSBC Global Asset Management. "Once you get down to a certain level, issues such as the size and reputation of the provider, the strength of their tracker portfolios, and the basis of the tracking methodology -- full replication, derivatives, or sampling -- take over."
"In short," he adds, "what investors are saying is that if there were no price differential between a provider offering full replication, and one using a complex derivative-based method, they'd probably opt for the simpler, more transparent, full replication."
It's an interesting point, and in a future article I plan on probing tracker providers' replication strategy in more detail. Watch this space.
More from Malcolm Wheatley:
Malcolm holds both HSBC and Vanguard index trackers.
